India: Industrial Policy, Liberalization and Impact

Syllabus mentions – Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.

Table of Content

Introduction

Why industrial policy?

Arguments against industrial policy

Common instruments of Industrial Policy

Evolution and Changes in Industrial Policy in India

Introduction

One of the most important tasks of the government is to manage economy of the country. It has to decide the means and methods to be used towards this. However, this job was taken up by almost all countries only after great depression. In pre depression era, there was faith in laissez Faire model of economy, which literally means – no intervention and let market forces of demand and supply have free hand. This is also known as capitalist mode of economy, where goods and services to be produced are decided by purchasing power of the people. In this model need of people is not deliberately considered, but it is believed that free markets will automatically take care of everyone’s need. If there are any mismatches in demand and supply, then price of the products will fluctuate in order to rope in or out suppliers and consumers and consequently there will be demand supply equilibrium. This kept government intervention away till the end of great depression of 1920’s.

Great depression brought spiraling hyperinflation which rendered wide range of commodities unaffordable to the masses. With this accompanied massive unemployment. It belied excessive faith placed in free markets and it demonstrated that markets are not sacrosanct as there was a big market failure. Famous economist John Keynes made out compelling case for government intervention, through incurring fiscal deficit to create demand. It was clear that government will have to manage production patterns of economy and promote production of specific goods in interest of consumers and employment. Roosevelt’s New Deal in US made it quite clear that now US government will intervene for promoting key industries.

Another major factor was of Russian Revolution. With establishment of socialist government in Russia, there was a sentimental wave against concept of free markets. Governments all over world extended franchise (voting rights) to working class in this period and limited the influence of capitalists. Henceforth it became easy and must for such governments to intervene in interest of all. This started era of planning to different degree in different countries. Socialist governments went for ‘imperative planning’ under which production was taken up by state and was distributed according to needs on proportional basis. For a socialist country this was quite natural, but surprisingly many erstwhile proponents of free market like France, USA also took up planning in milder form, which is called ‘indicative planning’. Under this, as already explained, government attempts to promote particular industries in interest of consumers and employment.

After Decolonization many countries along with India, had uphill task of socio economic development. Their economies were in past deliberately made heavily dependent on respective colonial ruling powers. Industries and markets were in infancy. New governments had to mark preferences for channelizing their scarce resources to achieve long term holistic development.

Due to all these factors, Industrial Policy was adopted by various countries and India was first noncommunist democratic country to have an official industrial policy.

Industrial Policy is a typical character of a mixed economy. It is policy of government intervention which is sector specific and is aimed at giving preferential treatment to a particular sector over others. Sector are recognized by policy makers, which are worthy of government support and targets are set. We have already seen government support toward renewable energy sector, organic farming, food processing and export promotion of various products. All these are part of Industrial policy.

Why Industrial Policy is Desirable?

Knowledge Spillover – Industries have a certain degree of knowledge spillover effect on the economy. Degree of this effect varies from sector to sector. A new industry will attract requisite skill/talent/expertise which will multiply overtime. Further, there will be some ancillary industries which may come up to support such industries. In short, focusing on a certain industry can overtime result in to a whole industrial complex which derives synergies and economies from each other. For e.g. Defense Industry could be benefited immensely if aviation industry, Software, Higher educational, Space exploration capacities are fully developed. So India’s space program provides synergy to defense capacity.

Infant Industry – At time of Independence, India’s industry was nonexistent in most of the sectors and those existing were infant. They had low capacity to adapt new technologies or to exploit economies of scale. In this case government protection is desirable in initial stages, so that a competitive industry develops at latter stages. Without government support or protection many of the present competitive Industries, would never have come up. In short, these industries need protection from foreign competition.

Coordination Failure – An industry doesn’t exist or survive in isolation. It needs other industries which feed to it raw materials at reasonable costs and quality. Further, many other industries that will act as customer are needed for survival of this industry. For e.g. Iron & Steel Industry is most important sector of economy. It is must for a competitive automobile sector, construction sector, Infrastructure, Capital goods machinery sector, Defense sector. On the other hand, Iron and steel sector can perform only if there is availability of coal and power. A good transport sector facilitates interaction and movement of goods in entire economy. In initial stages of an economy there’s often a ‘coordination failure’, which government tries to address by industrial policy. In India this led to recognition of ‘core industries’ which have multiplier effect on the economy, these are – Iron & steel, Cement, Crude Oil, Gas, Petro Refining, Mining, Power, Fertilizers.

Informational Externalities – Setting up an Industry requires certain degree of confidence in future of the whole economy and that industry in particular. There is reasonable risk which results in reluctance on part of investors. This risk and uncertainty is high in case of ‘first mover’ in a newly opened sector. This is because markets for new product are unchartered and untested, so there’s no reliable data or information on basis of which risk return calculus can be drawn. Consequently, governments hold hand of a few new units in that industry through industrial policy and then gradually leave them of their own. As we have seen in renewable energy sector.

Arguments against industrial policy

Influenced by Special Interests – There are always pressure groups in an economy that compete for resources of the government. They try to influence decisions of policy makers to corner a larger than deserved share of natural and economic resources. This way, often, personal interest prevails over national interest. This obviously creates avenues for corruption, rent seeking, patronage, ‘quid pro que’ as seen in elections.

Knowledge Deficit – Any industrial policy requires prediction of future trends in an economy. Our experience tells us that an economy is toughest to predict and efforts of planning and policy making often end up being futile. There are different think tanks at national and international level that come out with different economic forecasts. Hence, policy makers’ choice of forecast is a subjective one and success is only dependent upon other developments in economy.

Distortion of markets and production patterns – Government support distorts prices of products. Prices are signals which tell consumers and producers – what to consume and produce. So, due to government protection and support, producers fail to adopt latest technologies, new markets etc. This makes them uncompetitive.

Instruments used by Industrial Policy

India after Independence deliberately opted to promote Heavy Capital Industry which was to be under state control. This was implemented through five year plans. After 2nd five year plan, what is popularly called Nehru-Mahalanobis model was adopted. Investments were made through state owned PSUs in various sectors such as Hydro/ Thermal/ Nuclear power, Iron and Steel Industry (SAIL), Mining etc.

That time, there was another opinion from some eminent economists in favor of support to traditional handicraft sector and agro economy (which was Gandhian model) in India which was employment intensive; in this case, heavy industry will be left to markets. But Congress government opted for Mahalanobis model and debate over this choice still continues.

Nehru Mahanabolis model was instead capital intensive. There was strong affinity to heavy industry at that time. Developed countries’ progress and decent standard of living endorsed investment in favor of heavy industry. At same time government of USSR was pursuing rapid industrialization and our leader were in strong influence of socialist ideas originating in USSR.

To balance this loophole, India’s small scale industry was protected from external and domestic competition. For protection from external competition high Tariff and non-Tariff barriers were placed and in case of internal competition, and certain industries were reserved only for small scale sector.

Let’s have a look at common means, methods or instruments of Industrial Policy

Use of tariffs/non-tariff barriers and Subsidies – Tariffs are custom duty barriers which are used to protect domestic industry of a country from external competition. It renders costs of imported products artificially high and gives advantage to local manufacturers. Similarly there are quantitative restriction (non-tariff barriers) under which quotas are fixed limiting quantities of imports. In pre 1990 era, these both restrictions were extremely high. However, ‘Structural Adjustment Plan’ by International Monetary Fund and negotiations at WTO forced India to bring down these barriers.

Example of automobile sector – India in past kept custom duties on automobiles as high as 100-200%. This gave domestic automobile industry an advantage and opportunity to exploit domestic markets. Now we have domestic industry which is globally competent. Products from Maruti-Suzuki, Mahindra, and Tata etc. are also exported to many countries. In contrast, Pakistan afforded foreign automobiles unrestricted (or less restricted) access to its markets from very beginning. Consequently, it doesn’t have any competitive domestic Automobile manufacturing sector.

Another way of support is to provide subsidy, either on purchase, sale, or investment. Examples – for purchases farmers are provided subsidized fertilizers, for outputs they get price support and any investment in farm mechanization and processing industry is eligible for capital or interest subvention subsidy.

Import Substitution – Aforesaid policies are generally targeted toward ‘import substitution’. This means imports are to be avoided and products are to be manufactured domestically, even if their costs are substantially higher or quality is lacking. This policy led to development of capacity in technology and innovation to great extent in India.

Reserved Industries –

By this government reserves certain kind of strategic Industries for itself and others for Small scale sector (more on this later)

Apart from these there are other controls such as Licensing Requirements, under which operations can be commenced only after license has been granted and terms of operation of business will depend upon those mentioned in license.

Evolution of Industrial Policy

India was never industrially developed country prior to independence. It was an agrarian country where in handicrafts attained supremacy unmatched anywhere else in the world. There are very few lines of economic activity which became traditional in nature and could be included under the products produced under the factory system of 19th and 20th century. For instance silk manufacturing, utensil manufacturing, wood works, some products under pharmaceuticals etc could be categorized as industrial activity, but methods were often traditional and they had to compete with continuing industrial revolution of west.

Industrial policies and economic policies were shaped by the British Government in favour of British interests. The tariff policy pursued by British in India was based on the principal of one way free trade while the Indian interest for industrialization in India remained deliberately neglected. While British producers had unrestricted access to Indian markets, Indian products were kept at bay by British industrial policy. Only access was allowed to raw materials.

Though the British Government established Department of Commerce and Industry in 1905 but the activities pursued through this department favored industrial activity in England. Thereafter, the prevailing Government established board of Scientific and Industrial Research in 1940 but not much could come out of it. By this time there were numerous plans such as one by congress working committee, Bombay plan, Visvesariya plan etc. Almost all of them propagated heavy industries with dominant role of state.

In Independent India various resolutions were passed in Parliament from time to time, landmark shift happened in 1991 when India was forced to open up its economy to global competition and government had to deregulate sectors to leave space for private industry. Here are mentioned some landmark shifts in Industrial policy of India.

Industrial Policy Resolution, 1948

After gaining independence, it was necessary to have new policy for industry of the country, to decide priority areas and clear doubts in the minds of private entrepreneurs regarding nationalization of existing industries.

In Industrial Policy Resolution of 1948, both public and private sectors were involved towards industrial development. Accordingly, the industries were divided into four broad categories:

(a) Exclusive govt. Monopoly-This includes the manufacture of arms and ammunition, production and control of atomic energy and the ownership and management of railway transport. These industries were the exclusive monopoly of the Central Government.

(b) Government Monopoly for New Units-This category included coal, iron and steel, aircraft manufacture, ship building, manufacture of telephone, telegraphs and wireless apparatus (excluding radio receiving sets) and mineral oils. New undertakings in this category could henceforth be undertaken only by the State.

(d) Unregulated private enterprise-the industries in this category were left open to the private sector, individual as well as cooperative.

The main thrust of the 1948 Industrial Policy was to lay the foundation of a mixed economy where both the private and public enterprises were to be given importance and work together to develop economy to accelerate the pace of industrial development.

Industrial Policy Resolution, 1956

This was meant to give a concrete shape to the mixed economy model and the ideology of Socialist pattern of society.

The Industrial Policy Resolution of 1956 classified the entire industrial sector in three Schedules:

Schedule A: In the first category, those industries were included whose future development was the exclusive responsibility of the State. 17 industries were included in this category. This included heavy and strategic industries such as defense equipment; Atomic energy; Iron and Steel; Heavy castings and forgoing of iron and steel; Heavy plant and machinery required for iron and steel production for mining.

Schedule B: In this category those industries were included which were progressively State- owned and in which the private enterprises would be expected only to supplement the efforts of the State. In this category 12 industries were included.

Schedule C: All industries not listed in schedule A or B were included in the third category. These industries were left open to the private sector. Hence, the responsibility with regard to establishment, function and development was of private sector, though even here the state could start any industry in which it was interested.

Small Scale Sector – To encourage small sector, in the policy resolution, various steps were proposed such as:- (a) Direct subsidy was provided to small scale sector, (b) Suitable taxation relief was given to this sector, and (c) It was made objective of the State to protect small scale sector by advancing technical assistance. However, government failed to integrate these industries and their programs with the production program of the large- scale sector.

Foreign Investment – allowed foreign capital participation in Indian economic development but the major share should belong to India. In case of already existing foreign establishments, these will be replaced by Indian technicians gradually.

One of the major objectives of resolution was reduction in regional inequalities and imbalances. But contrary to this, the actual operation of this policy resulted in increased regional inequalities. This becomes evident from various reports which noted that the four industrially advanced States of Maharashtra, Gujrat, West Bengal and Tamil Nadu benefited the most from the operation of this policy.

Most important sectors were reserved for government, but government failed to develop on these reserved sectors. Occasionally, private sector was allowed to operate in these areas. As already mentioned, this was due to system of rent seeking and kickbacks which developed during this period.

The Monopolistic and Restrictive Trade Practices Act, 1969

This act was hallmark of infamous ‘license quota permit’ system. Companies having more than specified value of assets needed to take permission/license before any expansion and commencement of operations.

Its objectives were –

To prohibit monopolistic and restrictive trade practices (except by government)

To prevent concentration of economic power in few hands

To control the Monopolies

To protect consumer Interest

MRTP Act became effective in June 1970. Emphasis was placed on increasing productivity of industry. There were major amendments in 1980’s and a MRTP commission was also setup. This act was incompatible with new economic policy after 1991 and consequently, it was repealed in 2009. Now Competition Act and Competition Commission of India are in place instead.

Industrial Policy Resolution 1977

This resolution was result of change in government at center. Consequently, it had more focus on small scale industry, cottage and village industry. This was move away from Nehruvian- Mahalanobis ideology to gandhian ideology of economic development.

This classified the small sector into three categories:-

a) Cottage and household industries which provide self-employment on a wide scale.

b) Tiny sector incorporating investment in industrial unit in machinery and equipment upto Rs. 1 lakh an situated in towns with a population of less than 50000

c) Small-scale industries comprising industrial units with an investment of Rs. 10 lakh and in case of ancillaries with an investment in fixed capital upto Rs. 15 lakh.

Small Scale sector specific policies were made. Number of items reserved for this sector was increased (105 to 807). ‘District Industries Centers’ were established in every district, which are instrumental for support to small scale industry. This agency would provide under a single roof all the services and support required by small and rural entrepreneurs. Khadi and Village Industries Commission was revamped.

This resolution categorized large industries on the lines of Basic/core industry, Capital Goods industry, High Technology industry and other Industries.

It was also envisaged that all possible efforts be made in the direction of development of indigenous technology, which should ensure efficient production, continued inflow of technology in sophisticated and high priority areas where Indian skills and technology are yet not adequately developed.

Further, foreign investment would be encouraged only for some industries in the national interest as decided by the Government. This clearly meant that in areas where the foreign collaboration was not required, such case would not be reviewed. For this there was draconian Foreign Exchange Regulation Act in place.

Industrial Policy resolution, 1980

Congress made come back and soon restored its own industrial policy.

Major Changes were –

Some of the items reserved for small scale industry were de reserved.

Many units/companies were operating on excess capacities, than allowed by law. These excess capacities were regularized.

The year 1991 witnessed a drastic change in the industrial policy governing industrial development in the country since independence. This land mark change was entirely a new chapter which was to enforce totally open economic system as compared to the earlier mixed system. The country decided to follow the lines of capitalism. It is also said that there was shift from ‘imperative’ to ‘indicative’ planning under new system.

Features of New Industrial Policy

Industrial licensing policy – New industrial policy abolished all industrial licensing, irrespective of the level of investment, except for a short list of 18 industries related to the security and strategic concerns, social reasons, hazardous chemicals and over riding environmental reasons and items of elitist consumption . However, of these 18 industries, 13 categories have been removed from the list gradually and currently only 5 category of health, strategic and security considerations industries needs license viz. Alcohol, cigarettes, hazardous chemicals, electronic, aerospace and all types of defense equipment.

Policy on Public Sector – The 1956 Resolution had reserved 17 industries for the public sector. The 1991 industrial policy reduced this number to 8. As of now only 3 industries are reserved for government – 1) Atomic Energy 2) Mining of Atomic Minerals 3) Railway Transport.

The policy also suggested that those public enterprises which are chronically sick and which are unlikely to be turned around will, for the formation of revival/ rehabilitation schemes, be referred to the Board for Industrial and Financial

Reconstruction (BIFR), or other similar high level institutions created for the purpose, in order to protect the interests of workers likely to be affected by such rehabilitation package, a social security mechanism will be created.

Privatization/disinvestment

Government announced its intention to offer a part of government shareholding in the public sector enterprises to mutual funds, financial institutions, the general public and the workers. A beginning in this direction was made in 1991-92 themselves by diverting part of the equities of selected public sector enterprises.

Monopolistic and Restrictive Trade Practice limit

Under the Monopolistic and Restrictive Trade Practice Act, all firms with assets above a certain size (Rs.100 crore since 1985) were classified as MRTP firms. Such firms were permitted to enter selected industries only and this also on a case by case approval basis. In addition to control through industrial licensing, separate approvals were required by such large firms for any investment proposals. The New Industrial Policy removed the threshold limit in assets in respect of MRTP companies.

Policy on Foreign investment and Technology agreements

The New Industrial Policy, prepared a specified list of high technology and high investment priority industries, wherein automatic permission was to be made available for direct foreign investment up to 51 percent foreign equity. The industries in which automatic approval was granted included a wide range of industrial activities in the capital goods and metallurgical industries, entertainment electronic, food processing and the services sectors having significant export potential. List is being expanded since then. Current situation of FDI norms will be discussed in next article.

Abolition of Phased Manufacturing Programs for New Projects – These programs was aimed at indigenization of technology. These were in force in a number of engineering and electronic industries. The new policy abolished such program for future.

Removal of Mandatory Convertible Clause – In pre liberalization era, there was a mandatory convertible clause in loan agreement with borrower (industries in this case).As per this clause, banks had right to convert their loan amount into equity whenever they feel so. This will make them ‘owner’ from ‘lender’ in that enterprise. This clause was used by government as an instrument to nationalize private firms. This was removed under new economic policy.

New economic policy was culmination of long era of inefficient dominance of public sector. Nevertheless, public sector by this time had built strong industrial base on which other industries can thrive in future. This was one of the objectives of Nehruvian model. Unsurprisingly, Industrial and economic growth remained dismal during this period. Process of liberalization begun in 1980’s which showed up in better performance of economy. Recent high growth (as per some economists) can’t be attributed to initiatives of New industrial and economic policy as statistical evidence suggest better performance from early 1980’s. So much credit can’t go to intervention of International Monetary Fund.

In post liberalization era, government took up the role of facilitator and regulator. Some conclusive indications toward this are – replacing Foreign Exchange – Regulation Act with Management Act, latter one being more liberal and less harsh. Similar, MRTP act was replaced by competition Act. Now FDI is allowed in wide array of sectors, in many of them through automatic route. However, post 1991 growth is accused of lopsided growth with devastating social impact as government rolled back expenditure from social sectors too.

Note – Effects of Liberalization on various aspects of Indian economy and Society will be discussed in next article, along with post 1991 and current Industrial policies.